Principal residence rules | The tax planning guide 2015-2016

Principal residence rules

Your “principal residence” is generally any residential property owned and occupied by you or your spouse or common-law partner, your former spouse or common- law partner or your child at any time in the year. It can be a house, condominium, cottage, mobile home, trailer or even a live-aboard boat, and it need not be located in Canada. Any gain on the sale of a principal residence is tax-free. However, if you sell your residence, you should be aware that some tax rules apply.

Just because you live in a house that you own doesn’t automatically qualify it as a principal residence. For example, building contractors or house renovators who follow a pattern of living for a short period of time in a home they have built or renovated, and then selling it at a profit, may be subject to tax as ordinary business income on their gains.

Designating a principal residence

A home can be designated as your principal residence for each year in which you, your spouse or common-law partner and/or your children were residents in Canada and ordinarily lived in it for some time during the particular year. You’re only allowed to designate one home as your principal residence for a particular year. If you’re unable to designate your home as your principal residence for all the years you owned it, a portion of any gain on sale may be subject to tax as a capital gain. The portion of the gain subject to tax is based on a formula that takes into account the number of years you owned the home and the number of years it was designated as your principal residence. Suppose you and your spouse own two residences, a home in the city and a cottage out of town. Only one of these homes can be designated as your family’s principal residence each year. Before 1982, each spouse could designate a separate property as a principal residence for a particular year, provided the property was not jointly owned. However, for each year after 1981, couples and their unmarried minor children can only designate one home in total as their principal residence each year.

To help you make this designation, you should determine the fair market value (FMV) of both homes as of December 31, 1981. Factors to consider will include the relative appreciation of each house and the expected timing of any sale.

Tax issues

If you made a capital gains election on a residential property such as a cottage (see topic 135), the tax implications on the eventual disposition of the property will depend on a number of factors. These include the value of the property at the time of disposition, the number of years it was designated as a principal residence at the time of making the capital gains election and the years after 1994 it was designated as a principal residence. The rules in this area are quite complex and well worth a trip to your tax adviser’s office.

Tax tip: Be careful before designating a foreign-owned home as your principal residence. Even though the gain under Canadian rules is tax-free, you may incur a foreign tax liability when you sell your home.

Homes for rent

If you move out and rent your home, you can continue to treat the house as your principal residence for four additional years, or possibly more if you move as a consequence of a change of your place of employment with your employer. There are also rules that apply if you own property to earn rental income and subsequently convert the property to personal use. Basically, at the time of the change in use, you’re deemed to have disposed of the property at its FMV. If this value exceeds your original cost, you will have to report a capital gain. However, you can make a special election to defer recognizing this gain until you ultimately sell the home. This election is not available if you have claimed depreciation on the property for any year after 1984.